Monday, August 7, 2017

The failings of post-modern capitalism

Consider this narrative. A combination of economies of scale, first-mover advantages and network effects have privileged a handful of firms across industries. The superstar firms lobby hard to capture the government and set the rules of the game through regulation and occupational licensing, as well as seek innovative approaches to erect entry barriers to competitors. They attract the smartest talent and compensate them with exorbitant salaries, which often border on the vulgar, far far higher than those affordable for their also-ran competitors, thereby engendering an ever widening skills inequality. They raise capital at the cheapest terms while also crowding out capital to the remaining majority. Finally, and most disturbingly, they also exercise market power egregiously to accumulate massive surpluses, which in turn finds its way back not as increased investments and more jobs but returns to shareholders in the form of share buy-backs at inflated prices. The result is heavily amplified market concentration and declined competition. Finance and technology sectors dominate this trend.

As much as we sing paeans about these innovative and disrupting companies, this picture of post-modern capitalism is far from the orthodoxy associated with free market capitalism.

This trend is most egregious with technology based firms, where the popular perception endures of start-ups in garages creating entire markets or disrupting entrenched incumbents. Instead the reality has been of a small group of massive firms, which benefited from being at the right place at the right time to take advantage of a nascent industry with dominant network effects and regulatory arbitrage potential.

The US business sector has under-invested relative to Tobin’s Q since the early 2000s. We argue that declining competition is partly responsible for this phenomenon. We use a combination of natural experiments and instrumental variables to establish a causal relationship between competition and investment. Within manufacturing, we use Chinese imports as a natural experiment to test the main prediction of competition-based models of investment and innovation, namely that competition forces industry leaders to invest (innovate) more. We establish external validity beyond the manufacturing sector by showing that excess entry in the 1990s, which is orthogonal to demand shocks in the 2000’s, predicts higher industry investment given Q. Finally, we provide some evidence that the increase in concentration can be explained by increasing regulations and, to a lesser extent, stronger winner-takes-all effects in some industries.

Messrs Gutiérrez and Philippon benchmark investment against “Tobin’s Q”, the ratio of a firm’s market value to its book value. A high Q signals that an industry is earning a lot from its assets, which, all else being equal, suggests it should invest more. The authors show that America’s investment has fallen most substantially, relative to Q, in concentrated industries. In these sectors, investment has also fallen more than in Europe. To explore the issue further, the authors draw a distinction between “laggards” and “leaders”, defined as firms comprising the top third and bottom third, respectively, of an industry’s market value. Laggards, they reason, are more likely to wither in the face of competition, so their investment might be expected to fall. Leaders, though, should be up for a fight if rivals challenge them; their investment should rise. They find it is leaders, not laggards, who are responsible for the bulk of the investment slowdown, suggesting a lack of competition.

And its contribution to the declining labour share of profits relative to capital and widening inequality,

Recent research by David Autor of MIT and four co-authors finds that “superstar” firms pay out less of their profits in wages. As these firms have grown in importance, labour’s overall share of GDP has fallen. Other research suggests that these firms nonetheless pay more, in gross terms, than ordinary firms, so their rise has directly contributed to inequality.

Rana Faroohar has this to say about its impact on the labour market and labour share of the income,

Finance takes 25 per cent of all corporate profits while creating only 4 per cent of jobs, since it sits at the centre of the dealmaking hourglass, charging whatever rent it likes. Meanwhile, wealth and power continue to flow into the technology sector more than any other — half of all American businesses that generate profits of 25 per cent or more are tech companies. Yet the tech titans of today — Facebook, Google, Amazon — create far fewer jobs than not only the big industrial groups of the past, like General Motors or General Electric, but also less than the previous generation of tech companies such as IBM or Microsoft. What’s more, it is not just the top sectors that control the majority of corporate wealth, but the top companies themselves. The most profitable 10 per cent of US businesses are eight times more profitable than the average company. In the 1990s, that multiple was just three. Workers in those super profitable businesses are paid extremely well, but their competitors cannot offer the same packages. Indeed, research from the Bonn-based Institute of Labor Economics shows that the differences in individual workers’ pay since the 1970s is associated with pay differences between — not within — companies. Another piece of research, from the Centre for Economic Performance, shows that this pay differential between top-tier companies and everyone else is responsible for the vast majority of inequality in the US.

Finally, Gillian Tett points to Thomas Philippon and Ariell Reshef who have shown how closely linked pay has been to deregulation of the sector.

However one slices the data, the case for more employee power and use of collective bargaining, direct regulatory action on anti-competitive practices, and enhanced role for public policy to address the failings of excessive competition has never been so clear. Just as the welfare state saved capitalism from the onslaught of socialism in the immediate post-war aftermath, these policies may be needed now to save capitalism from capitalists.

Update 1 (31.12.2017)

The enduring low corporate investment rates in the US despite the extended low interest rate period and the record pile of corporate cash reserves has been one of the biggest macroeconomic puzzles.

German Gutierrez and Thomas Philippon have a new paper which did an empirical examination of private fixed investment in US over the past 30 years and have come up with a range of very important findings,

We analyze private fixed investment in the U.S. over the past 30 years. We show that investment is weak relative to measures of profitability and valuation particularly Tobin's Q, and that this weakness starts in the early 2000's. There are two broad categories of explanations: theories that predict low investment along with low Q, and theories that predict low investment despite high Q. We argue that the data does not support the first category, and we focus on the second one. We use industry-level and firm-level data to test whether under-investment relative to Q is driven by (i) financial frictions, (ii) changes in the nature and/or localization of investment (due to the rise of intangibles, globalization, etc), (iii) decreased competition (due to technology, regulation or common ownership), or (iv) tightened governance and/or increased short-termism. We do not find support for theories based on risk premia, financial constraints, safe asset scarcity, or regulation. We find some support for globalization; and strong support for the intangibles, competition and short-termism/governance hypotheses. We estimate that the rise of intangibles explains 25-35% of the drop in investment; while Concentration and Governance explain the rest. Industries with more concentration and more common ownership invest less, even after controlling for current market conditions and intangibles. Within each industry-year, the investment gap is driven by firms owned by quasi-indexers and located in industries with more concentration and more common ownership. These firms return a disproportionate amount of free cash flows to shareholders. Lastly, we show that standard growth-accounting decompositions may not be able to identify the rise in markups.

1 comment:

"However one slices the data, ... enhanced role for public policy to address the failings of excessive competition has never been so clear." It is not clear how the actions you refer to will have an impact on the problem . And, that may reflect the post-modern condition of late capitalism ! Is it excessive competition, or class based concentration ( tech+ finance) ?

There has been a lot of commentary since the financial crisis on aligning markets to society's needs. Between Macroeconomic levers of transmitting change (interest rates), and the newer variants to labour power ( immaterial labour, Lazaratto et al), the economy is far removed from the 70's / 80's - in terms of what construes reasonable actions to influence change.

A corrupt and hollowed out bureaucracy/ political class squandered any chance of a stable distribution led growth in the 80's and 90's. The crisis in health and education is a blow-back from the years where political opportunism passed off as policy.

Take agriculture, between the Farm gate to retail ( for example in Coffee), the inflation in returns could be as much as a 1000 %, largely captured within the commodity markets, branded retail trade, experiential delivery models ( coffee shops / bars etc.,) - the value capture is urban / financialized and immaterial in orientation.

The continuing boom-bust of asset-classes( ex. land / housing) reflects traditional methods of wealth protection/expansion gone awry, and the limits of macro economic policy in directing liquidity to where the social need is the greatest.

The insidious problem is of dysfunctional development models, as underlying assumptions for their relevance no longer obtain. This is where the key problems in debates on capitalism (late capitalism in this instance ) surfaces - a kind of superficiality, however data driven, that prevents us from scratching even the surface of the problem.

A particular condition of post-modern policy is the detachment of symbols from their referents i.e. the detachment of policy slogans from the lived experience (Hugh T Miller, Post modern public policy). Agriculture is an example of how sloganeering is all we got rather than capital investments, better water management ( rampant corruption in irrigation departments), and modernization all around. Our Agricultural bureaucracy is possibly the worst, for a country which is largely agricultural, with very low contribution to per-capita-GDP. Or, take growth, without distributive fall-outs or jobless growth driven by automation - growth that looks good on paper, but its concentration defeating the purpose of policy.

It is very likely that countries in Europe may be quicker to grasp the change, as the pressure of EU disintegration may force politicians to respond.

Our politics is simply a long drawn out melodrama (post-modern again!). However, there is earnestness now, to face our problems square. But, do we have the space for manoeuvrability in our policy / administrative regime to make fundamental changes ( higher taxes, broader tax base, more and efficient social infrastructure spending, cracking down on bureaucratic pilferage etc.,), remains to be seen ??.

Will we veer towards UBI(Universal Basic Income) or any other path breaking approach - one thing is clear, indirect policy transmission is slow, and social pressures could inflame to negate the gains of the consistent policies of the past few years.